How does your lender treat HOA dues in the DSCR? A four-condo package example

Question

Ran the numbers on a four-condo package recently and it turned into a clean example of how much one line item can move a DSCR. Curious how the lenders and landlords here handle it.

The package: four individually deeded units in the same complex, offered together at $345,000. Three occupied, one three-bedroom vacant.

Rents are $1,000, $1,100 and $1,300 on the occupied units, with a market estimate of $1,450 on the vacant three-bedroom. So $3,400 today and $4,850 stabilized.

HOA dues across the four units: $1,400 a month. That is 29% of stabilized rent. Add property taxes and roughly $2,100 a month of fixed cost sits ahead of the mortgage, about 43% of the rent. Annually that is $25,200 of fixed expense against $58,200 of gross rent.

Most residential DSCR programs put HOA dues inside PITIA. On a 25% down, 30-year illustration at 7.50%, that makes the qualifying payment $4,209 a month instead of the $1,809 of principal and interest.

What that does to coverage:

Current occupancy at $3,400 rent = 0.81, an $809 monthly shortfall

Stabilized at $4,850 = 1.15

Rent needed for a 1.20 = $5,051

Rent needed for a 1.25 = $5,261

To clear a 1.20 the vacant three-bedroom would have to produce about $1,651 against a $1,450 market estimate. Roughly $200 a month of rent decides whether the file exists.

More down payment barely moves it. 20% down reads 1.12, 25% reads 1.15, 30% reads 1.19.

Run it as a traditional NOI statement instead, stabilized rent less dues, taxes, insurance, 5% vacancy and 5% maintenance, and NOI is $23,580 against $21,708 of annual principal and interest. That is 1.09 before management. Add a property manager and it goes under 1.00.

Two questions for the group:

1. Does the lender you use put HOA dues inside PITIA or below the line? On a package like this it changes your maximum purchase price more than a quarter point of rate does.

2. On condo packages specifically, what DSCR floor are you actually being quoted right now, and does it change for four individual loans versus one blanket portfolio loan?

And for anyone shopping condos: pull the HOA budget, reserves, delinquency rate and any pending special assessment before you go hard. Dues rise on their schedule, not yours, and there is no way to raise rent to match mid-lease.

Door count is not cash flow. Interested to hear how others are underwriting these.

Stacy Raskin · Answer

HOA dues are part of the DSCR loan calculation.

There are DSCR loan programs that have a DSCR 1 ratio program with best pricing which means in practicality the rent and the expenses can equal each other but usually the actual or market rent on the appraiser's rent schedule is usually at least slightly higher than the actual expenses. There are no ratio programs where the DSCR loan ratio is lower than 1 or the property mortgage, taxes, insurance and HOA expenses (for 1-8 unit loan programs) exceeds the rent but the rate will be higher.

Richard F. · Answer

While delinquency can certainly be a factor, and I'm sure varies by market, the bigger issue that I have seen, and, as the Managing Agent, fought with the Boards over, is deferred maintenance and wildly inaccurate "replacement cost" numbers. Too many Boards, large and small, when not "overseen" by active participation of it's members, feel their "job" is to keep monthly fees low. They choose to adjust the reserve numbers to accomplish this, deferring tasks on "unimportant" elements. They fail in their fiduciary responsibility to the membership.

Even the reserve studies, and, I have personally worked with the company that had done reports for Surfside, often rely on numbers provided BY the Board...those same inaccurate numbers for replacement costs. Their reports still reflect a "range" of costs, but is likely weighted by the Board's input. Usually, a critical, visual, walk-around will reveal true signs of many issues.

The 70% figure is close, but it truly depends on the timing of the upcoming high cost replacements. If the asphalt, roof, and new fire system estimated due dates are spread over the next 7 years, that is one thing, but 2 elevators and an exterior paint due within 3 years is quite another.

Richard F. · Answer

Assuming a reserve funding plan for the current or upcoming year is available for the project, what weight do you place on the current "percent funded" when considering funding?

Robin Simon · Answer

HOA dues should always be in the DSCR Ratio - thats what the "A" is in PITIA!

#2 - condos (especially if its more of a "condo-site" in a 4 or fewer unit package) should have eligibility across the spectrum in DSCR ratio buckets, even under 1.00x or 0.75x if offered generally

Steve Waller · Answer

Good question, and honestly percent funded gets more weight from me than the dues number does, because dues are visible and a special assessment is not.

The way I use it: percent funded is the reserve balance divided by the fully funded balance in the study. Rough bands I work with are under 30% being a project where I assume an assessment is coming and I want to know when; 30 to 70% is ordinary and I read the funding plan to see whether they are climbing or sliding; above 70% I stop worrying about it and go back to the dues.

What makes it matter more on a package like this than on a single door is concentration. Four units in one complex means one assessment hits four times. Dues here are already $1,400 a month, 29% of stabilized rent. A special assessment of $6,000 a unit is $24,000 and there is nowhere to put it, because you cannot raise rent mid-lease and the file was 1.15 stabilized to begin with.

The number I read alongside it is the delinquency rate, because percent funded is a snapshot and delinquency is the leading indicator. A project at 55% funded with 3% of owners behind is fine. The same 55% with 18% behind is a project where the funding plan is fiction, since the money in the plan is money they are not collecting.

Coming out of 35 years in commercial credit, the thing that still strikes me about residential DSCR is that on a commercial file we underwrite a replacement reserve as a hard line item, and then on a condo package we take the association's word for it. The reserve study is the one document in the package that tells you what the building actually needs, and it is the one nobody reads.

So, heavy weight, but as a pair. Percent funded tells you the size of the hole. Delinquency tells you whether it is still getting deeper.